Warner Bros. Discovery Inc (WBD) — Q1 2019 Earnings Call Transcript

Good morning, everyone. And thank you for joining us for Discovery's first quarter 2019 earnings call. Joining me today are David Zaslav, our President and Chief Executive Officer; Gunnar Wiedenfels, our Chief Financial Officer; and JB Perrette, President and CEO Discovery Networks International. You should have received our earnings release, but if not, feel free to access it on our website at www.corporate.discovery.com. On today's call, we will begin with some opening comments from David and Gunnar, and then we will open up the call for questions with David, Gunnar and JB. Before we start, I would like to remind you that comments today regarding the company's future business plans, prospects and financial performance are forward-looking statements that we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are made based on management's current knowledge and assumptions about future events, and may involve risks and uncertainties that could cause actual results to differ materially from our expectations. In providing projections and other forward-looking statements, the company disclaims any intent or obligation to update them. For additional information on important factors that could affect these expectations, please see our Annual Report for the year ended December 31, 2018, and our subsequent filings made with the U.S. Securities and Exchange Commission. And with that, I will turn the call over to David.

Good morning, everyone. And welcome to our first quarter 2019 earnings call. We’ve started the year with very strong operating momentum across the company, with positive financial results domestically and internationally, as we continue to create, develop and acquire the highest quality content with broad consumer appeal in every market around the globe. I have made it clear that Discovery’s strategy is different than any other media company. While everyone else is focused on big and expensive movies and scripted series, which is a very crowded space, we have a different approach. We have brands that people identify with and love. We’re gaining distribution in all key bundles in the United States and around the world and enjoy a unique global footprint. We have a proven management team, which I believe is the best in the business. We have a de-levered balance sheet and capital structure that gives us great optionality. I believe we are the leading global IT company. And we have important, entertaining and useful content in categories that are loved, trusted and safe. Our content has the broadest multi-generational consumer appeal and high perceived value among advertisers and distributors. We are powering people’s passions in genres that are central to their lives, and we have niche channels, quality brands and talent that people around the world trust, respect and believe in. And we are now starting to see the results. From revenue to adjusted OIBDA, to free cash flow and of course, virtually all operating metrics, we are seeing healthy momentum. We are benefiting from continued merger synergies from the Scripps acquisition; from strong consumer demand that is driving our adoption in multiple distribution packages and bundles in the U.S. and around the world; and progress we are making in building out our suite of direct-to-consumer products with best-in-class IP in passionate entertainment and sports categories. Discovery looks different. Our strategy is different, and different is really starting to pay off. And what a difference a year makes. This time last year, we had just closed on Scripps. There were questions about the future of our businesses, our lack of inclusion on virtual MVPDs, our ability to leverage home and food around the world and the amount of debt we had taken on to close the transaction. A year later, while we don’t have all the answers yet, we have made remarkable progress. We have proven the durability of our core business, the value of our beloved brands in an OTT world and the opportunities made possible by our global reach to consumers in nearly every country. We have reduced our net leverage to below 3.5 times, and we are seeing a healthy acceleration of our core businesses across the board. We are excited about our growing portfolio of new global direct-to-consumer services and the management and engineering leadership we are recruiting to Discovery to continue driving the strategic advantage we have in our own technology infrastructure. Domestically, we've continued to make great headway toward near ubiquitous distributions of our key channels across the virtual MVPD landscape, most recently with an agreement to launch nine of our brands on YouTube TV. We now have the most widely distributed cable network group across all key OTT players. Our team has done a terrific job advancing our position. We are thrilled to partner with YouTube, Hulu and Sling, ensuring that we are well positioned to grow as consumers migrate to new bundles and platforms. Additionally, our U.S. rating trends across many of our key networks continue to improve. In the first quarter, we had the top four cable networks on commercial delivery for women in prime from 8 to 12, with ID, HGTV, Food Network and TLC, which is pretty remarkable and a first ever in the cable industry, helping us to drive domestic advertising at the top end of our peer group for a couple of quarters in a row now. I’m pleased with our performance and the trend lines we are seeing with our domestic advertising business. But as I said last quarter, I think we have some real productivity headroom and we have a number of initiatives in place to advance our returns. The team has really dug in and we continue to innovate through our targeted cost platform marketing capabilities. With 4% domestic advertising growth in Q1, I once again feel great heading into this year’s upfront, our second as a combined company, and we’ll keep you posted on our progress. We are also pleased with our progress and outlook for our international segment as the Scripps content is beginning to gain real traction in key international markets. Building upon the heavy lift we detailed last quarter with regards to layering in Scripps content across our networks, we have also been hard at work launching new pay, free-to-air and digital branded services. We recently announced we will be launching HGTV as a new free-to-air channel in the large advertising market of Germany. We also have secured healthy subscriber commitments throughout Latin America, with the new HGTV channel launching across all key countries, while at the same time, we are nearly doubling the distribution presence for the existing Food Network channel across the Latin America region. We continue to assess demands in the market and what opportunities exist to fill those holes, both in the linear and digital ecosystems. We are gaining real traction in securing some truly premium IP programming and talent across a number of initiatives. We believe our ten-year global relationship with the BBC will be a key milestone for Discovery. We created a stronger and more efficient UK business that will soon rationalize the UK TV portfolio; secured some of the highest quality blue-chip series for our linear networks, such as SERENGETI, which may be one of the most visually stunning pieces of programming I have ever seen coming to Discovery Channel this summer; produced by Simon Fuller and Perfect Planet, which was produced by Alastair Fothergill, who did Planet Earth for us, which is coming in the fourth quarter; and we have the new co-development team at the BBC hard at work creating a pipeline of high-profile landmark factual programming over the next several years that we will harvest for Discovery in the U.S. and around the world. The most strategic element of our BBC deal was securing all of the SVOD rights for the BBC Library of factual landmark series and specials, a marvelous library for the factual and natural history genre. Our ambition is to take that library along with the best of the Discovery Channel, Animal Planet, and Science Library, together with additional exclusive original content, brands and IP in the genres of natural history, science, adventure, exploration, history, space and technology, and package it together into the definitive natural history and factual streaming platform in the world and take that global. It is the perfect moment to create this type of service, high in both entertainment value and global impact and relevancy. Blue Planet 2, for example, not only ranks among the all-time top shows ever aired in the UK, it ignited a major global call to action, after an episode on the effects of plastics in the oceans led to a ban on plastics in the UK and now adopted across the EU. It is this wonderful content and IP we can aggregate around the globe. As we continue to build out our portfolio of brands and world-class content, we are thrilled to be back in business with Chip and Joanna Gaines. They are true singular talents with great creative vision and an authentic ability to connect with audiences. Millions of fans follow their storytelling through the home, the kitchen, the garden, and they incorporate strong family values more seamlessly than anyone else. We really want to win together and we are excited to help showcase their passion and talent. Discovery will launch a multi-platform global media business around their Magnolia brand, by rebranding DIY next summer, alongside an authenticated go-app. We will then launch a streaming OTT platform service in 2021. GOLFTV is another example of where we have strengthened our content offerings with the best talent, most valuable IP and strong global programming. We’re off to a terrific start. The support of Golf is on fire globally and our timing couldn’t be better. Though still early and in beta, we are seeing real signs of traction in users on GOLFTV, both paid and registered, especially in countries with local heroes, like Japan and Italy, and in markets where we have taken advantage of Discovery’s local presence. In Asia-Pacific specifically, we are seeing a nice boost across our portfolio given the local must-see nature of Golf. In places like Japan, where we have put together a great partnership with J:COM, it’s a great template as we look over the next three to four years for when we will have the full global rights to the PGA tour outside of the U.S. and be able to offer PGA, Tiger, as well as all of our Golf products everywhere in the world in a fully integrated ecosystem. We’ve successfully streamed over 35 tournaments across five tours with healthy user engagement, particularly for our Tiger content; Tiger’s Masters' victory was clearly one of the all-time great sports moments, and it’s a welcome and powerful storyline for Golf. We will be rolling out the exclusive Tiger Woods and structured master class series later this year. This is just the tip of the iceberg. I couldn’t be more excited about where this partnership with Tiger can take the platform over the coming years. Finally, the global cycling network brings together entertainment, functional content, deep engagement, and mobile commerce into an immersive lean-forward experience, a great example of what we mean when we say view and do, and this is beginning to gain some meaningful traction. Every month, millions of cycling enthusiasts not only visit the site; they immerse themselves in the site and with its community. They’re checking out the Maintenance Monday repair videos, seeking help with how-to and asking CCM through the platform and other social media. They are training along with our pros on famous terrain videos. They’re coming to our live forms, races and training camps, it’s a full 360-degree cycling experience. We believe all these initiatives make Discovery a stronger company; being consumer obsessed is our mission and guides everything we do. Last year, we reached outside of our industry to bring in a top executive from Amazon, Peter Faricy, who ran marketplace to further guide us in this mission. Peter has already added enormous depth to our senior team, has opened up a new office in Bellevue, Washington with a growing product development and engineering team with great depths of differentiated experience and perspective in building leading digital consumer products. Our office in Bellevue, Washington will be a new hub, driving platform excellence to support our strong global IT. While our eyes are very much focused on the path that Peter and team will lead us on in the future, we are supporting an underlying core business that is still very healthy and growing. There is perhaps no stronger reflection of our underlying operating momentum than having achieved the upper end of our leverage target nearly one year ahead of schedule. At under 3.5 times net debt to adjusted OIBDA, down from over 4.7 times a year ago, we are finally in a position of being more opportunistic with our excess capital. As you’ve seen, our board has authorized a $1 billion share buyback, which with our strong free cash flow, which over the trailing 12 months basis was over $2.8 billion or about $3.1 billion excluding cash severance, secures our ability to continue to reinvest in our growth strategy as well as further reduce our financial leverage to align our capital structure to accommodate both the cyclicality of our industry and requisite investment demands. We are in a great position. This optionality affords us the flexibility to intelligently and judiciously allocate our large and growing free cash flow to further enhance our existing portfolio. We enjoyed a uniquely deep level of engagement with our viewers and consumers, and they look to us to nurture their passions. It’s a completely different strategy than most of our peers are pursuing; we are playing in a different sandbox than anybody else. We have a different look, feel, and appeal than almost all other network groups. As I said earlier, we really see that different is paying off. Against the backdrop of continued disruption across our industry, I feel confident with our strategic response, balancing industry headwinds by refocusing and repositioning our portfolio of recognized global brands into immersive passion-driven experiences. We are supported by a strong and de-levered balance sheet throwing off a lot of cash, providing us with great runway and real optionality. We are confident in our ability to continue to execute during this time of disruption and great opportunity. Thank you. I will turn the call over to Gunnar to take you through the financials and the outlook.

Thank you, David. Thank you everyone for joining us today. I'm extremely pleased with our very strong first quarter operational and financial performance and with the strategic progress we have already made in 2019 as we continue to transform Discovery. I remain very optimistic about our company’s outlook. Let me first share some financial highlights from our first quarter, which caps-off the first full 12-month period since closing the Scripps transaction. My commentary will again focus on our pro-forma results, and we’ll be in constant currency terms for the international and total company commentary unless otherwise stated. Please refer to our earnings release filed earlier this morning for all of the details regarding the drivers of our first quarter financial results. In the first quarter, Discovery achieved or exceeded all of our revenue guidance metrics with 4% U.S. advertising growth, 4% U.S. affiliate growth, negative 6% international ad growth due to the tough comparison for the Olympics last year, which should accelerate slightly towards the fourth quarter, and finally, 1% international affiliate growth. We also grew total company OIBDA by 21% due to continued strong synergy realization and due to the Olympics comparison internationally. Total operating costs were down significantly, with declines in both cost of revenues and SG&A in the U.S. and abroad. This led to 43% total company margins, up 900 basis points year-over-year, with U.S. margins expanding 700 basis points and international margins up 1,000 basis points. Additionally, we reported $498 million of free cash flow in the first quarter of 2019, which brings our trailing 12 months free cash flow to roughly $2.8 billion for the first full 12 months as a combined entity, which is after more than $300 million of cash severance, restructuring costs, as well as higher digital spending in the same 12-month period. Our laser focus on cash flow and cost management has allowed us to end the quarter with the net leverage ratio below 3.5 times, sitting inside the top 10 of our target net leverage range well ahead of our original stated goal to be back within our target range of 3 to 3.5 times by early 2020. Against the backdrop of this strong improvement in our financial positioning, I’m pleased to announce that our board has authorized share repurchases of up to $1 billion. We continue to feel very comfortable with the company’s outstanding ability to generate cash. This authorization increases our optionality and gives us yet another lever to create shareholder value. Regarding capital allocation, our priorities stay the same. Number one, optimize leverage. Within our 3 times to 3.5 times net leverage range, we currently plan to prudently de-lever towards the lower end of this range. Number two, at the same time, we will continue to evaluate value-enhancing investments back into our business and strategic M&A. And number three, returning excess capital to shareholders. Before I move on to our forward guidance, I would like to comment on our recently announced UK TV transaction that results in our 50-50 joint venture, and the formation of our new SVOD partnership with the BBC. As part of the JV resolution, Discovery will take full ownership of three lifestyle channels in the UK. The transaction is currently expected to close by early June with the following financial impact. Discovery will consolidate the three networks post close, so we will no longer be including the small amount of earnings from our 50% share of UK TV earnings in our equity earnings line. We will also receive cash payments of around $240 million in total over the next two years. All of the three lifestyle networks' revenues currently come from advertising and will be consolidated post-closing, providing a couple of hundred basis points uplift to international advertising growth assuming the full year of contribution. From an adjusted OIBDA perspective, we expect the 2019 impact will be minimal, but ultimately we would expect a more meaningful impact over the next six to 12 months as we integrate the networks and capture additional synergies. We are also extremely excited about the new 10-year SVOD agreement, which will showcase iconic BBC natural history content. Any costs associated with this had already been incorporated into our digital investment guidance that we gave during last quarter’s earnings call. Now let me share some forward-looking commentary. I will start with our four key revenue drivers on a pro forma constant currency basis for the second quarter of 2019. For U.S. advertising, growth is expected to be similar to the range of the first quarter, up 3% to 5%, driven by similar dynamics, continued pricing increases, and the continued monetization of our digital and Golf product, partially offset by lower linear ratings on a year-over-year basis. Our ratings performance for the quarter, as always, will be a key determinant of where we will fall within our guidance range. We would note we expect continued outperformance versus the market, helped by our recently announced YouTube deal, in addition to the uplift from now having additional mix on Sling and Hulu. Second, U.S. affiliate growth is expected to accelerate versus the 4% in the first quarter, primarily due to additional virtual MVPD carriage. As noted, the first quarter should see the lowest growth of the year. Though, as always, this assumes no major changes in subscriber counts. While there are lots of moving pieces, both headwinds and tailwinds, we still feel very comfortable with our full year guidance of U.S. affiliate revenue growth in the mid single-digit range, especially given our recently announced YouTube deal, and now best-in-industry representation across domestic, traditional, and virtual distribution platforms. Third, international advertising growth is expected to be up mid-single digits. We expect sequential improvement across all regions and further continued monetization of our digital products. Note this also assumes around one month of contributions from the three new UK TV networks. Finally, international affiliate growth is expected to be up low single digits. Underlying trends remain relatively consistent with last quarter across our markets, and we also continue to drive monetization of our digital subscription products. Turning to total company guidance. As noted, we still expect another year of healthy free cash flow goals in 2019. We will continue to be laser-focused on driving free cash flow growth even after making the investments necessary to build out our direct-to-consumer portfolio. Our view on the puts and takes behind our ultimate full-year free cash flow results have not changed versus what we laid out last quarter. As we had outlined, growth will be based on adjusted OIBDA growth and lower cash restructuring expenses, partially offset by increasing investments in direct-to-consumer, higher CapEx and higher cash taxes. I continue to expect an incremental $200 million to $300 million of direct-to-consumer investments over last year. The negative impact on the full year 2019 adjusted OIBDA is still expected to total around $300 million to $400 million on an absolute basis. Please note that a vast majority of the spending is still to come and will be back half loaded given the timing of the rollout. Given this cadence, as well as the fact that we have now completed the full four quarters of initial cost synergy capture post the Scripps deal closing, full-year margin expansion will primarily be driven by the upside from the first quarter versus additional year-over-year margin expansion in the second to fourth quarters. Moving on to taxes. Please note there is a one-time accounting-driven and non-cash structural impact that will significantly lower our book tax rate in the second quarter and in the full year 2019 that I want to draw your attention to. As part of the integration of Scripps, we are in the process of streamlining and rationalizing our global legal entity footprint. The most significant accounting implication from these internal restructurings will be a one-time $450 million to $500 million tax benefits in the second quarter, as we are recording deferred tax assets, which will make our second quarter book tax rate a negative one. With that, we now expect our 2019 full year book tax rate to be in the low to mid single-digit range. Again, this is a non-cash benefit and there is no impact to our cash taxes or to our free cash flow. Before I close, let me quantify the expected foreign exchange impact on our 2019 results. At current spot rates, FX is now expected to negatively impact revenue by approximately $180 million to $190 million and adjusted OIBDA by $70 million to $80 million versus our 2018 reported results. In closing, I remain extremely satisfied with the financial footing of Discovery and optimistic about our outlook. Our strong balance sheet and financial performance will allow us to accelerate the transformation of our business, drive free cash flow, and ultimately generate significant long-term value for our shareholders. Thank you again for your time this morning. Now David, JB, and I will be happy to answer any questions you may have.

I guess my question for David perhaps is on the international side. It looks like you guys are making a significant push internationally. You had such great success out of your legacy Discovery business and now you’re making a bigger effort on the Scripps side as well. Can you talk about how big the opportunity is for the Scripps assets? And when we might begin to see some of these newer initiatives you’ve talked about earlier in the call result in outcomes? And then I have a follow up after that.

Historically, we’ve gotten most of our growth by gaining market share. When you take a look at our international results now and as we look going forward, we think we’ve really turned the corner regarding our acceleration. Our market share is growing broadly. And now on the advertising side, we see mid-single digits, which is a real acceleration. In the affiliate, we see low-single digits. So we’re back to being a growth business again. The Scripps content is starting to work in some markets really quite well. But I'm going to pass it on to JB as we talk about how we believe we’ve made this turn. It's been a lot of hard work. JB is on the ground running that business.

Alexia, as David said, when you look back a couple of years ago, it's a great growth story. The international business has really been driven by share growth, as David mentioned. After utilizing a lot of the Discovery legacy content to its maximum, that growth began to slow. Over the last six to nine months, as we’ve ingested Scripps library and started to take more advantage of it, we’ve really seen content driving better audience share performance in a major way. As an example, in the UK, we had our best quarter ever from a share perspective. Unfortunately, the advertising market in the UK was still down mid-single digits, but our shares were way up. While we’re not expecting a major turnaround in some of the more challenged international markets, what I find particularly optimistic and positive about what’s coming is that our shares are growing, the Scripps content is working better and helping. We’re also launching new networks such as the launch of our free-to-air HGTV in June in Germany, the biggest ad market in Europe, and we are doubling our footprint from a penetration and subscriber perspective with Food Network in Latin America. So we’re seeing the theory we talked about a year ago of utilizing the Scripps content really working well across Europe and Latin America, in particular. As David referenced in his comments, we’re also seeing improvement in Asia, which has been a trouble spot for us historically, where golf has completely changed the game for us. We are now engaged in active conversations in markets like Korea, which have been underrepresented by Discovery historically, about launching new channels and exploring new opportunities in the business.

Just a quick follow-up on your comments on the use of cash. Thanks for that. I just wanted to clarify. Can we assume that you can balance being active in the new buyback authorization while prioritizing investments in the business and potential M&A?

I think that’s a good summary, Alexia. As I said, for the time being, we also focus on bringing down leverage a little further to the lower end around 3 times rather than 3.5 times, given where we are in the transformation. Other than that, our priorities haven’t changed. We’ll continue to make all necessary investments in the business and drive future growth. We’ve talked about all the organic investments that we’re making, and we’ll continue to balance that. I'm very, very happy with where we are. Keep in mind, it’s been 12 months; we’ve reduced our leverage by 1.2 turns, $2.8 billion cash flow generated in the first 12 months after closing the deal. So I think we’re in pretty good shape and have a very, very strong balance sheet at this point.

This team is really impressive. The Scripps transaction has really worked. We’re now free and clear of that. We have some more synergies coming through. We were at about $1.4 billion of free cash flow; they were at $700 million. I’ve been saying for a long time that if we could really execute, this transaction makes us a free cash flow machine and set out a target of $3 billion that we would more than double our free cash flow. The execution has put us in a position now where we’re a year ahead; we’re below 3.5 times levered, $2.8 billion in cash, $300 million on transactional-related costs; and we’re now in a position to have full flexibility to invest in our business, look at acquisitions. There's a lot of companies now that we have the flexibility to consider strategic assets that provide sustainable growth, buybacks and de-levering a little bit more. We’re going to be generating a lot of cash. We love where we are right now; we don’t see any major M&A; but the idea that we have all this cash and the ability to use it strategically in an unencumbered way around the world is just an exciting moment for the company.

I wanted to ask about the competitive landscape for non-fiction programming. It seems that non-fiction would fit naturally into an SVOD service but most major services are really focused on general entertainment and you characterized that as crowded in your opening remarks. Hulu made an announcement about some cooking themed shows. Any sense that SVOD services are moving into non-fiction? And I guess the broader question is how should we think about your advantages as an incumbent non-fiction provider?

When we look at IP, we've worked very hard over the last five years to transition into really compelling IP, and what will people pay for before they’ll pay for dinner is our mantra. The excitement for us is that Netflix, getting to 250 million subscribers, has created a road and a path where people get used to paying for content. Fifty percent of what people watch on TV is scripted series and scripted movies, and they’re going to be able to gorge on that stuff. There's a wealth of opportunities from $7 to $15, and it will go up over the next couple of years. People will probably have one, two, or three of those and they'll love them, and maybe they’ll churn between based on who has the great series or who has some great movies. That's 50% of what people love. There's another 50% of what people love and that’s what we have. There’s really nobody in our space. Yes, Hulu is doing a few food shows and Netflix does some stuff, a little bit of natural history. But all of the BBC content is coming off of Netflix. The ability to create series and new big event programming like Planet Earth 3 is coming to us globally everywhere in the world, and the next Blue Planet is coming to us. Our ability to use all of that IP is compelling. In addition to that, those brands stand for significant entertainment—that’s why people buy them. They want to see the great series like Mrs. Maisel or Game of Thrones, and that’s the business they’re in. We are really much more in two different businesses; we think Natural History can be massive. Every family, everyone in the world should want to have this. As I’ve said, it will be less than $5, but it’s a product that more and more is about learning, being smarter, being aware of the planet. This young generation cares deeply about what’s going on, and we’re going to be documenting the planet. We’ve received huge feedback from a lot of players that say they want to be part of this, in front of the screen and behind the screen. In each of these areas, we have a real expert team working with great producers, many of whom only work with us because our production in each of these areas is so strong. I think it’s a wide open field for us, and ultimately, we should be able to build significant businesses around all of them. I think the biggest one being Natural History and Factual, which is a global initiative driven by family values. Whether it’s games, opera, food, home, or crime, I think we have a real opportunity, and it’s exciting because everybody is chasing that same ball, and we feel like we're the best in the field and we're seeing it with Golf and cycling already that it’s meaningful.

I have a couple of questions. I've lost track of how many direct-to-consumer services you're planning to launch in the next two to three years. But I'm curious about your approach to the revenue model. Can you discuss the balance between subscription and advertising in both U.S. and international markets? My second question is about advertising. You've conducted some upfront presentations. How do you think the selling approach will differ this year, and what are your expectations for the market? Lastly, you're in a unique position, as you mentioned earlier, being part of every virtual MVPD and traditional distributor, especially given the loss of subscribers in the traditional space. What insights do you have from that perspective? Overall, where do you see the market heading for Pay TV subscribers in the bundle?

One, I’ll just start with the bundle point. The smaller bundles, I’ve been saying this for a while. We’ve seen it outside the U.S. where if we can get to eight or four, we tend to do much better on the advertising side. Our brands get stronger, our content is viewed more aggressively. If we can capture 85% to 90% of our revenue, we end up with a net positive, and in some markets, very positive. It’s very hard for us to project where things are going. But we are on older bundles now and we’re moving toward all of them. The skinnier bundles, in many cases, may be much better for us because people will spend more time with our channels; it’s a younger audience, and we’ll be able to monetize them with better CPMs. The good news about us right now is whatever happens, Malone said to me four years ago that the key to long-term sustainable growth in a business that has challenges is to be on every platform. If you’re on every platform, you’ve got a real game. If you can be on every platform and have top services on those platforms, then you can find significant growth, even in a business that’s in long-term secular decline. That’s the position we’re in. We’ve worked hard to get there. On those new platforms, we also get a lot more data and analytics that give us superior CPM. So it’s really additive in that regard. On the pay and free, we’re already in the market with MotorTrend, and it’s doing very nicely for us. We have Eurosport Player, which we’ve been at for 4.5 years. We’ve learned a ton. It’s what led us to Golf and cycling as individual sports; being transactional and providing a full social ecosystem, as well as information that people can read every day like they read a daily magazine, we’ve talked about Natural History. But in each of these, there are two pieces. There’s the funnel where you can go and see stuff for free. So eventually, Golf might be a hundred million people who are playing around the free funnel and then we can promote in every country everywhere in the world what we have. Funnel number one is almost nobody else has in every language. Funnel number two is the free funnel, where you don’t have to give us your credit card, and you can just hang around and see some Tiger, or see some of the golf, or play around with the cycling. Here, people talk about what else is going on behind the paywall. We can monetize that from an advertising perspective, which we are. Then that leads into the pay. Each of these will be the triple funnel. One of the reasons we got the PGA and why we’re so confident about our ability to aggregate and scale is we have these affinity groups globally in every language spending time with us. We did this with Eurosport; we built the Eurosport Player for free with 30 million to 40 million people across Europe. They come to us as the number one place people seek for free. Then we can say to those people: here’s what we have behind the wall. There’s no other company that can do this; look at affinity groups in every country. Then you get the credit card. We’re at the very beginning of this, but we think this could be quite compelling. We’ll deploy our capital as we see it. If Golf looks like it’s accelerating in a meaningful way, we’ll invest more heavily in that. Cycling is a significant global business and opportunity for us, and we’ll spend more money there. On Natural History, we’re ready to spend a significant amount because we believe everyone that has Netflix or Disney’s product or HBO should also have this companion product, which provides kids with the greatest science and Natural History, teaching them all about space.

I agree with all of that. And then, Jessica, I think one additional point is what you may see is that this evolves over time. We have that unique position of having that global footprint in place with linear networks across the world. Some of the deals may be sublicensing elements in individual territories—that's the benefit we have in combining the total rights that we’re buying, of our long deal terms. We own our content and have our international complete global footprint in place. So from the perspective of our ability to exploit this content and contain the risks with some of the investments, I think it's the best position we could be in.

The upfront looks—we finished our five-city tour. We hit the upfront as strong, or stronger than we’ve ever been. We have the top channels for women—we are the number two TV company in America in terms of reach. Now we're number three but only by a smidgen, with Disney pulling in Fox. They were a little bit bigger than us. But we are one of the three big scale players in the marketplace, and the upfront feels pretty good. Scatter is strong; that’s accelerated. We feel stronger probably in every way. But the last few weeks have been very, very good. Some of it may be that there is a lot of underperformance at the broadcast and in other places in the cable industry. There is not a lot of inventory out there, and a lot of people have a lot of make-goods. We don’t know whether we’ve been getting a unique advantage or if that’s simply the current situation. We also have, as we go into the upfront, we think we have a unique advantage, which is if not a good it’s a baddy for us, but it’s a goody if we can turn it. That is that you look at two guys in front of us—their prime CPM is $55 plus. CBS's is $55 plus, and so is Fox. So we got the four players around us in price at $55 plus. We’re aggregating audience in prime across our networks. That’s bigger than all of them, and we’re at a fraction of that. That’s always been the case with cable. But now I went myself and that with every major agency, and I’ve been meeting with clients, saying, broadcast is terrific, you can do the $55 and the $55 plus, whatever the increase is in the upfront, whether it’s 7, 8, 9, or 10. But you could also move some of the money that you’re paying $56 or $58. We can give you a spot where you reach everybody at once across all of our top networks. We can deliver 20% of women in America. We can deliver 20% of prices. We could do unique things with our advertising. How quickly that will happen remains to be seen. I’ve been all over it. We’re starting to get some traction. The final thing is the broadcast inventory, in general, as you go through the rating declines that they’re experiencing, together with the fact that there’s more sports in broadcast. Broadcast prime is shrinking. That’s a real goodie for us. Then we have DGO, our authenticated apps where we’re doing better than anyone else, because we have passionate affinity groups that have downloaded those apps and are spending a lot of time. So I think we are probably as well-positioned as anybody right now, and we’ll just have to see how the market plays out.

I just want to go back to the U.S. affiliate guidance, the mid-single digits you guys have. I wondered if you could comment on what assumption is baked into that number with respect to subscribers. You probably should pull out the virtuals, right? You guys have picked up a whole bunch of incremental carriers. I’m just trying to understand how you guys are thinking about the traditional facility-based sub counts for the balance of the year?

Again as I said earlier in the call, we’re very confident in our mid-single-digit guidance. In terms of assumptions, that guidance is always a probabilized estimate of all the various individual drivers we’re seeing. Clearly, YouTube is helpful, as you pointed out, for MVPDs in general. That’s a strong point this year. You’ve also seen traditional subscriber numbers that came out in the first quarter, and that’s certainly working against the trend to some extent. But again, we have a lot of confidence. Our core networks in the first quarter were down. But we have larger numbers for the digital, which are looking strong. You can expect a little more support starting from the second quarter with YouTube rolling in, and we’ll evaluate from there.

Another question on free cash flow. You mentioned that when you look at the trailing 12 months, you’ve done $3.1 billion excluding restructuring charges—a reported really impressive number. The street is sitting at about $2.8 billion, $2.9 billion of free cash. Can you help bridge that? I know the quarter was quite strong. But can you help bridge that? The street is basically not forecasting much growth. Are we being too conservative on the outlook for free cash flow in 2019?

Drew, two months ago when we reported fourth quarter earnings, I said that we feel very strong about our ability to generate cash flow. I'm very happy with the first quarter numbers. A couple of points to remember when we reported 2018; we are going to see some more CapEx; and we are going to make those additional incremental investments in digital. For what it's worth, we haven’t seen the incremental investment mentioned in the first quarter, and there’s a lot coming through towards the second half of the year. I continue to see a total absolute dollar amount of $300 million to $400 million of negative impact on our P&L when we ramp up all the initiatives we have been working on. But, that being said, I also see a lot of opportunity. The restructuring expenses are going to come down significantly. I feel very good about it, but as I said when we spoke last time, we want to maintain the flexibility, because some of those investments are going to be on different timing and there’s some variability. I don’t want to put out any specific guidance at this point, but I’m very confident.

David, on the Natural History and factual OTT service, which hopefully you'll give a name to relatively soon, so we know what to call it, any thoughts on at what point is there a trade-off between building these OTT services and your affiliate negotiations with Pay TV providers, even for the digital channels that are already seeing bigger declines? Gunnar, as these services get launched, is there any rule of thumb that we can use in terms of how many subscribers you would need to breakeven? David, you talked about the total addressable market being fairly large for the Natural History and factual OTT services. Is there any target that we should keep in mind as we think about the growth prospects for those businesses?

First, Discovery is primarily a series-driven product. It tends to be the number one channel for men around the world. Looking at our audience, the majority is coming from series. We’re going to put in some meaningful upside on Discovery around the world and really supernourish the brand by bringing in more blue-chip content through the BBC relationship, as well as some other blue-chip content that we’ve had in the works. The blend could be 90-10 or 80-20, mostly series with big tentpole content. The Natural History and Factual product is completely different. We have the entire BBC library, all their titles; we have our blue-chip library; we have all of our space content, all of our STEM content. We have the best and largest science library in the world. With 5G coming into homes and the ability to show—a series like When We Left Earth, which is an eight-part series where we took all of NASA's family library, converted it into HD, and put together a great documentary. If you like that, you will want to see another 150 different series that will help you learn about space or podcasts. We see this as both entertainment and life learning. Families who want the greatest IP out there in terms of blue-chip will do a real deep dive into history and science and space. We will create a space where people can hang out like they do with Netflix, very differently than Discovery, or Animal Planet, or Science. But we will promote. We have those affinity groups that are dedicating time with us, and we’ll be pushing back and forth; but one is not a replacement for the other.

And Doug, on your breakeven question, I totally understand the desire to get some support in modeling that out. Obviously, we have our business cases. We’re looking at our discussions and scenarios. We’re evaluating all of those questions from a management perspective. But we’re realistic enough to know that we don’t have all the answers yet. Some of those assumptions are going to change as we go through the rollout either because we’re learning or because we're making different decisions. If we find something is really starting to work well, we might want to get behind it with additional content investments, additional platform, whatever. I don’t want to create any expectations out there, so this is the number of subscribers we need to reach breakeven. That’s why we’re absolutely not at the point to communicate anything there yet. Operationally, we’re absolutely focused on creating great products and understanding user experiences and engagement metrics at this point, much more than financial metrics and revenue growth and breakeven.

The key is, before we took the approach to drive scale. We want first to create a great product that people love, a Golf product that people say, 'If you love Golf, you don’t have this. You’re crazy; this is the greatest thing.' That’s what we’ve been finding now with cycling. We have an ecosystem within cycling that people are talking to each other about. It’s quite compelling, and we believe is going to lead to significant subscriber growth. Then we can apply a rigorous subscriber acquisition program, allowing us to drive revenue growth. JB has been on the ground around the world, looking at the interest in Golf and balancing that with Peter as well, because we both think it could be significant.

The exciting thing we see from a global opportunity is that these opportunities right now are still very early and we are at the beginning. We have a playbook that we know extremely well. If you think of the Discovery playbook of taking products out of the U.S. and taking them around the world, that has been our marquee for over 30 years. The GC and cycling example is an English-language product today that is working incredibly well. We are deploying that excellent playbook where we’re launching in German, in Spanish, and in Japanese, utilizing the Discovery infrastructure to help localize it. The growth opportunity is tremendous as we do that across different products, and we’re just beginning to get to the point where we think we can really scale those in a large way as we take them around the world.

David, you mentioned that digital is a boost to advertising spend, and you talked about some of the watch content earlier. I see that you're now reporting a billion dollars in advertising quarterly. How significant is digital in this context? Can you elaborate on the key factors within digital that are driving growth? Additionally, a quick question for Gunnar. In your Q4 results, you stated your core networks were flat, but this quarter, they were down 1%, which surprised me, especially since you introduced Hulu late in the quarter along with Sling. Is this decline a result of traditional players, or are some MVPDs losing subscribers due to price increases in Q1? I'm trying to understand the sequential slowdown you observed. Thank you.

Rich, I think, number one, you’ve seen the numbers that have come out on the traditional side. One technical point is when we talk about subscriber losses on a quarter-by-quarter basis, we’re looking at the end of the quarter numbers. You’ve essentially had Sling and Hulu in the number for the fourth quarter. You wouldn’t expect any incrementals outside of the growth of those platforms. Clearly, YouTube has not come on yet, and that’s the explanation for that discrepancy you’re seeing there. Regarding the size of the digital businesses, again, we don’t carve that out; it’s part of our reporting segments. I should say that it's still very small in terms of absolute numbers, but given its contributions to growth, it may be more significant. The most important aspect here is TV everywhere; our Discovery Golf platform, which we’re selling on an integrated basis with linear traditional advertising, has been contributing to our growth quite nicely for almost two years now.

Rich, you’ve heard us talk about some of the challenges we face in the Nordics and Northern Europe, which have been aggressive impacts on declines over the last several years. We’ve been trying to find that hard with pricing growth on ad sales and getting our digital products into better shape. The exciting thing for us in that market is we’ve finally seen over the last few months a return to growth, largely driven by digital, both ad and the fact that, through Peter's work and his team's efforts, we’ve improved our product from a two-star rating to a four-plus rating. We’re starting to see subscriber growth turn around and turn that region back into a growth story, which has been a real plus for us after some challenging years.

Two points, JB just said it, but bringing in Peter comes with a team, including one of Amazon's top technology executives. They’ve created a command team in place; we said, 'Look, we got to make our existing products better.' So we de-play a lot of great content because we are the major player in Northern Europe with free-to-air and cable. By improving the product ratings from two stars to over four, we started to see acceleration in average watch time and the number of people recommending it. I think our products are getting better; it’s a process. On the digital side, it’s encouraging from a consumption perspective. As I talk to my peers, no one has Discovery. They don’t have DGO products; you can’t have DGO for a general entertainment service. You have DGO because people love food and they will authenticate, and it’s cumbersome for them to watch our content but stay engaged with it, and that’s scaling in a meaningful way. We’re getting a lot of data; people are spending more time with us. The most important piece is the average audience age—we’re seeing it in the 20s. By continuing to put ourselves in the market through authenticated platforms, we are seeing that younger demographics appreciate our content. The advertisers are responding positively, so that’s a significant plus for us.

Two questions, David. One, you talked earlier about productivity headroom in ad sales. I think you mentioned in the U.S, and that is your largest revenue stream. I wonder if you could talk about what you all are doing there. You mentioned some initiatives to try to drive that even higher in any timeline we should be expecting. Secondly, you mentioned that now that you've de-levered, you’ve got a lot of flexibility to look at strategic assets to help sustain growth. I know you don’t want to be specific nor should you be. But when you think about Discovery, historically, international was the driver of growth pre-Scripps, and Scripps has made you a much more U.S.-based business from an EBITDA perspective. I'm just wondering if adding international depth and breadth is something that you think would be interesting for the company longer-term.

We look at everything, but we really like the company we have right now. We have the only thing in our way is ourselves and satisfying the consumer with something they love. If we do that in this global IP company, it’s going to take off. You look at this quarter coming in, we were mid-single digits. Our advertising, domestic and international, along with our affiliate metrics look remarkably positive. We have a growth business; that is what we are seeing. We know we have great content and we aren’t isolated to any specific business. On ad revenue, we’re behind and we’re still punching really low. We’re the third-biggest TV company in America. Unlike tuning in for a series, people are watching HG and Food like they watch Fox News or more. Our reach is bigger than all of them as we are serving up meaningful, high-media CPMs at lower costs than the networks would typically state. We have been outperforming the marketplace with a great sales team, and on traditional metrics, expect to continue outperforming in a meaningful way. Broadcast is going to decline much faster than our business. Our team emphasizes that we have great upside. The average CPM for broadcast is $55, and for us, it’s around $20 or less. We can provide a great opportunity for advertisers to come in toward the brand-level use. We use our results to drive engagement. The primary issue in the process for the overall advertising environment is still moving in a transient way. As we continue to meet with clients about our partnerships, they are receptive and listening.

Ben, can I add one point to the question about the locale of our investments? Given that much of what we’re doing into the direct-to-consumer space is driving those $300 million or $400 million investment today, as discussed, all of those initiatives are global in nature. By that very fact, many will hit our D&I P&L, both regarding initial startup losses but also, in cases of success, regarding growth rates. I also want to be clear that we feel very strong about what we have. There is no need for making any further investments; there is nothing coming through the pipeline that’s visible right now—but just standing clear on that as well.